Only Rubes Buy Individual Stocks

For some reason, my brain remembered this phrase as “chuds” instead of “rubes,” but either word works exceptionally well here. Chud, in particular, is a fantastic term. It has some onomatopoeia to it, as if one was asked, “What sound would this ugly, fat person make if he was dropped out of a tube of chocolate from a height of 10 feet?”

I’m an unabashed stock picker. My portfolio consists of 100% hand-selected stocks, and we’re talking about close to a million bucks, not some small-fry $1,000 selection here and there.

I don’t own a single index or mutual fund.

Am I stupid? Let’s find out!

Preface: most people should buy and hold index funds

Generally, you should buy and hold index funds. This article is an explanation and defense of investors who choose a different strategy. I am not advocating that ANY ONE go out and buy individual stocks.

I’m explaining how I invest and why I choose this approach over the standard advice to index. Plenty of investors follow a similar strategy, and this article is, in some ways, a shout-out to them.

A litmus test for stock picking

Quick test: you have $100,000 and must pick one of two stocks to hold for 30 years: Tesla or Pepsi?

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If you picked Tesla, stop reading here. Go index, or else start educating yourself and don’t buy an individual stock until you’ve spend 5,000 hours reading Jeremy Siegel, Charlie Munger, Philip A. Fisher, and Joshua Kennon. This is an incredibly easy decision, and it’s not even close. It’s equivalent to seeing Robert De Niro sitting next to Danny DeVito and being asked: “Real quick, who will look better in a couple decades?”

Tesla stock = Danny DeVito

Funds vs. Individual Stocks: It’s all the same when you drill down

Show me an investor’s historical buy/sell orders, and I can tell you a lot about that person. As investors, we all have such a ledger, though it’s often obfuscated behind layers of abstraction. If you put $1000 into SPY today, you are buying:

$41.11 of AAPL

$32.86 of MSFT

$28.75 of AMZN

$19.42 of FB

$15.92 of JPM

etc…

To feel some level of extra safety because you “index” is to delude oneself. You’re still buying individual stocks, just a bunch at a time, and some of them quite unsavory.

Side note: the modern linguistics of ‘to index’ as a verb are curious. Its transitive usage has fallen out of favor, except maybe among database analysts, and yet that definition is still listed as #1. Instead, the colloquial usage of ‘to index’ today means “to buy a fund of stocks, generally selected by a weighting formula, e.g. by market cap” In Merriam-Webster, you don’t even see the words ‘stock’ or ‘fund’ or ‘invest’ in their definitions. The rapid evolution of the language here is indicative of herd mentality to me. In the personal finance community, we can shorthand a sentence like “Just index.” And everyone knows what you mean, and most people nod in agreement.

Do you sleep well with your investments?

I invest for a 50-year horizon, and I’m conservative. I wouldn’t sleep well with:

14.166% of my portfolio in Financial companies

26.152% of my portfolio in Information Technology companies

Combined, over 40% of my wealth would be concentrated in Finance and Tech if I held SPY.

For a portfolio designed to last 50 years, holding that weighting would be batshit insane. Here’s why:

Financial companies have a tendency to self-destruct every decade or two in the natural ebb and flow of capitalism. It would take some serious cajones to “hold tight” to Fin+Tech during 2008. Banks were straight up collapsing, and no one knew who was next in the line of dominoes. The game only stopped when the United States Government stepped in to provide backing to the entire financial sector. I couldn’t do it, and I can’t/won’t subject my future self to that kind of stress. Does the current administration have a modern day Timothy Geithner? Do you even recognize that name? He may have single-handedly saved the entire world economy a few years back.

Information technology is, hands-down, the most creative/destructive sector in which to invest. The sector grows fast, but as Jeremy Siegel points out in The Future for Investors, “For the long-term investor, the strategy of seeking out the fastest-growing sector is misguided. (51)” Growth does not equal return, as the fall of firms like Blackberry can outweigh the rise of Microsoft.

“Sell stocks” was a popular term during 2008’s -25% drop in SPY and again during a quick/brief -10% drop in early 2018. Sell when the market drops and buy when it rises? That makes no sense.

A note about this chart: see that big spike over in February 2018 for “sell stocks”? That happened with a quick 10.1% peak-to-trough drop in SPY. From its height in September 2008 to its low in October 2008, SPY moved -24.34%. Any predictions for what “sell stocks” trends would look like today if SPY dropped ~25% in 60 days?

I see three factors that lead to this February 2018 “sell stocks” search spike (on a modest 10% drop) being especially high:

More people are searching now, for everything.

Although modest in its size, the dropoff was especially quick and induced a lot of fear. The amount of money at stake is at an all-time high. People are jittery right now.

We live in a social media age. 2008 was not a social media age.

Investing: Behavior vs Modeling

I think that these two questions are fundamentally different:

Define the optimal model of investing for a group of people.

Define the optimal model of investing for an individual.

Individuals tend to lag the performance of investment models because of their behavior. Investors deviate from their investment plan based on current conditions. Their behavior is strongly influenced by mental models and psychological ticks.

Know thyself.

I know how I respond when Kraft Heinz drops 42% because it just friggin happened. I started buying in the low $70’s (fair value) and am still buying to this day (good value in the $60’s, great in the $50’s). It’s one of the world’s most dominant firms in an industry ripe for conservative investment, and the M&A approval for AT&T just cleared the way for more industry vertical consolidation, the core aptitude of 3G and KHC management. People will still be buying ketchup in 2050, and KHC will still be selling it for profit. I’ll be taking my due slice of EPS then just as I am now.

How would you respond, dear index investor, if SPY dropped 42%? Please note that the general public is not panicking about Kraft’s supposed demise, but if the overall market dropped this far, what would your conversation with your hairstylist be about? How would it influence your buy/sell orders? Did you experience 1999 or 2008 and have background data for your guestimations of your behavior?

Investor behavior and psychology

Chris and I recently discussed the lollapalooza effect of rapid technological and social changes. He asked me, “Sheesh. What’s the world gonna look like in 5 or 10 years?”

I replied, “I have no clue. But I do know McCormick & Schmidt will be selling spices for profit in 10 years.”

Investor behavior on the Buy side

On the Buy side, it is incredibly difficult for a value-oriented investor to execute a Buy order on SPY right now. SPY looks expensive, full stop.

However, that same investor may look at Johnson & Johnson and decide that the valuation is reasonable in the $120-$130 range.

Would that investor be better off in cash because he’s afraid of buying SPY at all-time highs when leverage is maxed, subprime ARM’s are making a comeback, and there is a potential crisis in leadership brewing at the same time as financial and geopolitical jitters are echoing throughout the system?

Or would that investor be better off executing a buy order on JNJ at $125 because he’s confident that Band-Aids™ will still be sold a decade down the road, even if all of the scary events in the previous paragraph happen simultaneously?

Buying some abstract “The Market” versus buying a specific company, with a specific debt profile, product mix, and multiple $1B+ brands – that’s the type of decision we’re considering here. The decisions are not comprised of some optimal, formula-based model that a financial analyst can determine for a group of people: “This method is better.” Investment choices come down to the exact Buy and Sell orders that an investor executes:

Actual Behavior versus Theoretical Model

Investor behavior on the Sell side

Back to investing psychology: the mere-exposure effect, combined with social proof, is what spurred a 70-year old relative of mine to call her financial advisor no less than ten times in a week during October 2008. On the tenth time, despite her advisor’s adamant protests, my relative gave the final order to sell all of her stocks. All of them. She sold all her funds in October 2008!!!

From fear, from exposure to TV news, and from social proof – she made the worst possible investment decision at the worst possible time. She was a thoroughbred fund investor, but this approach to investing didn’t help in her time of mental peril. Had she instead focused on the number of bottles of Crowne Royal that she was drinking while she clutched shares of Diageo, she might’ve made a better decision.

Key advantage of individual stock investors: avoid dumb investments

It’s dumb to buy a cruise line operator or a shipping company. Why? Capital investments and lack of a competitive advantage.

If you have a massive, $2B MSC Cargomaster of the Seas ship, which gets 0.004 mpg moving cargo from a supplier to a port of high demand, you have a great business.

However, a rival shipping company that buys the latest and greatest $2.5B Cargosupermaster of the High Seas, which gets .0055 mpg will steal your orders, and your business has just sunk to the bottom of the sea! To add insult to injury, your already-depreciating asset also dropped in value significantly.

Investing in cargo shipping is stupid: high capital requirements and low competitive advantage. (Side note: at the right price, obviously, it makes sense. Figuring out that price is too hard, easy to move on to better business models.)

Now look at another part of the same shipping industry: rail. No one is laying new rail alongside Norfolk Southern’ 26,300-mile US East Coast network. To lay ownership claim to rights of way and rights of trackage along the greatest consumer corridor in the world: that is a MASSIVE competitive advantage.

Investing in rail is smart. Investing in nautical shipping is stupid. An individual investor can tilt toward the former and avoid the latter.

When you’re investing for decades, some categories can be easily divided into smart and stupid investments.

Smart:

Food/drink

Healthcare

Energy

Stupid:

Mining

Banking

Technology

“Stock pickers” as we’re disparaged aren’t out here searching for the company with the latest and greatest cruise ship, and we’re not scouring tech IPO’s to find the next AAPL or FB, and we’re not flipping back and forth between NFLX, TSLA, TWTR, or whatever the flavor of the week happens to be.

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About The Author

I'm at the tail end of a white-collar career, an age when many of my peers are moving into middle management or senior leadership roles.
Combining a keen sense of frugality with a high income, I was able to sock away a substantial amount of money early in my life. Helped along by a perfectly timed recession and subsequent bull market, my passion for investing turbocharged my retirement efforts, and I’m on the verge of submitting my notice. But first – I have some loose ends to tie up and a few extraneous goals to meet while my marketable skills are at their peak.

19 Comments

Couldn’t agree more. While I have nothing against index funds, you do lose a little control as you can’t choose what you are investing in. Like your portfolio, mine is really lacking in the financial sector. The only financial company I own was able to actually continue to raise their dividend during the financial crisis of 2008 and not put themselves in hot water or fear of bankruptcy. They kept their books clean and didn’t partake in the crazy leverage numbers that doomed so many others around that time. Technology can be hot and cold as well. Any industry that Amazon wants to enter has the potential to wipe out smaller competition. So if I am investing in technology, it will be a more reputable company that has proven it will be around for a while like MSFT. Which just so happens to pay a consistent dividend as well. Also keep the long term strategy. It was those who bought companies like KO and other consumer staples during the down times that helped make them money when the market finally rebounded again. Thanks for sharing!

You definitely lose that control, and many times end up still investing into the stock you might buy individually (like JNJ or APPL) – it is just that you want to more heavily invest in that company compared to the index fund – and buy it at a great price!

Totally on the same page with you on technology companies, MFST has been killllling it! I love their new surface lines, office365 is still in big businesses, and Azure is growing super fast.

The long term strategy wins in the stock market, just takes that Warren Buffet temperament to stick through the tough short terms at times :). We got this!

I love me some $MSFT in the tech sector, but it is incredibly difficult to value. Despite its massive cash horde, the current stock price makes it look quite expensive, but may be worth much more than its current price despite an incredible recent run. Azure is downright incredible, and it’s taking over in the way that Windows did in the 90’s and 00’s, just more quietly. It’s too hard for me right now to say ‘yea’ or ‘nay’ on $MSFT at this price, but it I’m leaning toward ‘yea’.

Your $CINF investment looks interesting. I’ll have to take a look at that one. I’ve done a little bit of business with the company, but haven’t evaluated it as an investment. For me, it might have too much overlap with $BRK.B, of which I’ve been buying fistfuls now that I’ve maxed out my retirement accounts and have space for a non-dividend stock.

I initially started reading your blog because I wanted to know what a rube was, but I totally agree with you. Although I have both individual stocks and Mutual Funds. I said the same type of thing in my blog how to beat the market.

I think he was speaking more about companies like Google who make most of their money from Ads (A LOT OF IT) or Netflix, because they are hard to truly understand (do you really know how Google’s algorithm works? Does Netflix really have a value of their super high stock price right now?

I believe Jack was saying he prefers companies with tangible production and assets they are selling. I’m putting words in his mouth though lol!

AT&T looks very attractive around $30ish, for a leveraged asset play in a booming media market, driven by ownership stakes in 1) generation/recycling of IP and 2) the distribution of the resulting IP.

Rates are low, and I don’t mind asset-heavy companies using debt to expand business, buy back shares, expand their IP portfolio, secure rights to distribution channels (e.g. spectrum licenses, easements, ROW’s, real estate, towers, distribution rights, copyrights, etc…). One problem with $T is that its share base has been expanding around 14% per year for the past 5 years, and that’s a lot of dilution. In return, investors received equity in merger activity.

It’s an aggressive move in my portfolio, and to be honest, I haven’t bought any yet. It’s been on my mind. i have a substantial amount of money in boring, conservative companies that don’t do any big moves (relatively) and just churn out cash year after year on low-to-no debt capital structures.

There’s room in my portfolio for a big swing at $T and $GE, both of whom are competing for my ‘leveraged homerun swing’ dollars. I don’t have many of those available, because I strongly prefer my stalwarts in $JNJ, $DEO, $HSY, $KMB, $PG, $MKC, $KO, $CL, $MCD – just really boring picks where I load up on dips and never, ever sell. Those guys generate the ‘house money’ that I can use to swing at the fences on something small like $ROST or an aggressive M&A participant like $T. I think $T and $DIS have a lot in common, and I already own a bunch of the latter.

My current portfolio does not include any individual socks. It is made up of only mutual funds and ETFs. For me, it is just easier and less time consuming. My Uncle who taught me a great deal about investing built a multi-million dollar portfolio of blue-chip stocks. An enterprising investor can achieve high returns with individual stocks, but it comes with more risk.

The term ‘enterprising investor’ shows you’ve done a bit of reading (Graham and his ilk). I love this stuff, it’s fun to me, and my portfolio is tied to a few key purposes in my life. Growing it enhances the way I can live and the way I can give back to the world. I’m hoping to put in this effort, achieve incredible results, and give back in big ways. The hours I put in to reading, thinking, and calculating may or may not be worthwhile when I could just throw everything in $SPY and spend my time doing other things. But building my wealth is strongly tied to more morally and ethically sound motivations, and so I focus on my investment activities with glee.

I think you should perhaps take your own advice in the first paragraph as there’s little convincing evidence here to suppor the individual stock argument. Suggesting broad-based index funds such as S&P can be bad because of they are overweight (I’m your view) in certain sectors is inaccurate, as indexes by their very nature move with the market. So if an industry crashes and burns, stocks are quickly replaced with the new next best thing. Whereas your individual stocks – god forbid, should your view on certain sectors be wrong – disappear into oblivion, never to be seen again. Your comparison if Tesla vs Pepsi may seem like an obvious choice, though in a different period, you might very well have used General Motors as your point of comparison and ‘obvious’ choice against Tesla. There is nothing wrong with investing in individual stocks, it’s a personal choice and for sure there’s more of an excitement factor than the index alternative. But genuinely believing that you know better than the market and can consistency over decades outperform it is a fools errand. Nothing against your writing by the way, I thought it was very well written… just lacking a balanced viewpoint 🙂

AGentfire – thanks so much for jumping in to provide some balance to the arguments. I find ‘just index’ to be a very compelling approach. It’s what I would recommend to everyone and anyone, even myself. There’s personal motivations and justifications behind my efforts to build my portfolio.

I am, by no means, attempting to convince people to follow this route. There are people who are already building their own portfolios to achieve their goals. Some of those goals are lifelong projects. I think we should celebrate people who are investing with passion and an eye toward commendable goals. However they accomplish this — be it by becoming a successful art investor, real estate mogul, franchise owner, or DRIP portfolio maestro — fuckin’ go for it. This article is in defense of and a celebration of investors who choose to build a portfolio of high quality common stocks. It’s a wise way to run one’s life, few people do it, and those that do shouldn’t be labelled as ‘rubes’ when they may well be the millionaire next door.

You are correct that $TSLA vs $PEP is a specious argument. It’s a terrible comparison, completely different enterprises and industries, but it was meant as an example of the price disparity that’s in the market today. Some valuations are downright STUPID, and we will one day recollect the 300X and 1000X P/E ratios with utter contempt. I don’t want any part of these stocks. Why would I dedicate some 10%+ of my portfolio toward dumb investments by buying an index fund? I’m avoiding those stocks, and that’s what the $TSLA vs $PEP comparison was meant to illustrate.

I think it’s important that people get a little excited about their portfolios. There was a time that I was incredibly excited to pour money into a 40%/30%/20%/10% :: Large/Mid/Small/Intermediate-Bond portfolio and re-balance annually. That works.

But it’s hard to do psychologically (for me anyway). When macroeconomic conditions deteriorate, if I’m investing in EVERYTHING, and my media consumption is nothing but big RED [OMG! GREAT DEPRESSION #2!!!!] — it’s hard for me to behave properly as a fund investor. By holding individual companies, I can focus on their actual earnings and not glaring headlines. That microeconomic focus on Income Statement and Balance Sheet keeps me grounded and improves my investing behavior.

Nowadays, I prefer to sit on a group of (now 27) stocks that are gushing with cash across all major sectors. I take that cash and pool it with excess money from my personal cashflow. Periodically, I invest in one of those thoroughbreds or select a new equity to add to the stable. I enjoy the process, and I can see on the horizon a final product that will fund a series of lifelong goals.

If you go with a good quality mutual fund or index fund, you’ll do about as well as the market. Nothing more, nothing less. That’s well and good if you’re interested in being mediocre.

The problems with indexing are threefold:

Market beating performance happens all the time. Contrast the S&P with the record of stock pickers like: Peter Lynch, Warren Buffett, and David and Tom Gardner.

Some investing schools provide a return advantage. For example value investors tend to have a .5 to 2.0 performance margin over growth investors.

Indexing has unintended consequences for capitalism as a whole. It encourages people to invest passively and it tends to prevents large concentrations of ownership. This removes a natural check which keeps capitalism honest – shareholders who own enough stock and care about the ethical and economic performance of their companies. So, with indexing, managers and hedge fund bosses are in control, not share owners.

So, if you’re taking a drink at the Indexing fountain, be sure you go into it with open eyes.

I think the main reason people don’t do well with individual stocks is that they are quick to monkey with things. They sell out if their stock goes up to lock in a profit, or down to cut a loss. To paraphrase Peter Lynch, they sell all of their winners and keep all of their losers, which is like cutting all the flowers and watering the weeds. The biggest secret is to hold on since most big movements up happen over really short periods of time, so if you’re constantly moving in and out of stocks and you miss that big move up, you’ll earn 2% instead of 12%. If you do hold, and you concentrate and buy 500-1000 shares of your top picks, you can make huge gains over a decade or two.

I love this post. This is my new favorite blog you guys are awesome. I never see anyone who bases an investment on a 50-year or even 30-year outlook. You guys obviously read all the good books (Poor Charlie’s Almanack, Intelligent Investor, etc.). It’s funny to me people don’t take advice like this and fret over individual stocks if they haven’t taken the time to learn anything.

They’re always better off investing in an S&P 500 index fund, but hardly ever do, at least from my experience talking to people.

I invested in Apple when the stock went down from $129 to $105, $96 and $89. After it went up to $150 or so, my advisor told me to sell some because he didn’t think it was likely to go up anymore. I obviously didn’t listen, but it’s at $207 right now even after their share price dropped over 6% from the iPhone sales report and I don’t care and people don’t understand why!

People look at me after I tell them I invested in Apple when it was cheap like I’m so good at investing, but every time I tell them to read the books I read and they’ll be fine, but then never do. People make it way more complicated than it needs to be.

Also for anyone who wants to borrow it, I have a copy of Seth Klarman’s Margin of Safety if they’re interested.

$AAPL is a smart investment, but it feels a bit gambly to me because of how quickly the phone market can change. My big qualm with them (not unique at all) is how reliant they are on iPhone revenue. If that ever crashes in a big way, Apple could run into serious trouble. The counterbalance to that is the mind-boggling cash horde and a more-likely-than-not scenario that iPhone revenue actually grows significantly in the next 5-10 years.

It’s a business that gushes cash, and so it qualifies to be on the shortlist. I’m investing indirectly through $BRK.B, though $AAPL has been on my radar more than few times over the past couple years. It all depends on price and the other opportunities available. < $200 looks like fair value, and < $150 looks like a steal. You got in at a great time!

As of today, I'm looking hard at $GE, $BUD, $SYF, $KHC, $XOM, $BP, $RGR, and $ROST (begging for it to hit the $80's again). There's been some serious market adjustment these past few months, a few stocks soaring while others nosedive. Opportunities abound, as always.